I have to say, I'm puzzled. Recent developments in the euro zone seem incredibly negative to me. The probability of a reasonably orderly conclusion of the crisis appears to be falling. Yet equities aren't dropping; indeed, they're up from early September. Has the roadrunner sprinted off the cliff but not yet looked down? Or am I missing something?

Avent is trying to wrap his mind around equity market behavior. I wish him the best - I hope he gives me a call if he finds a meaningful answer. All I can say is that we have been here before. Recall 2007:

By the middle of 2007 the TED spread was exploding, signaling enormous financial turmoil. Yet equities kept heading upward, fueled by data that was just not that bad coupled with ongoing expectations that a solution was just around the corner. And now we find ourselves in almost the exact same position. Avent is correct, the news out of Europe is abysmal. He is not missing anything. There is no solution, no magic summit at hand. At this point, it is a choice between severe recession and depression. There is no happy ending to this story.

Consider the news from Greece. CR points us to Athens News, which declares the Greek government rudderless. The latest EU demand, that everyone in power sign a commitment to the last bailout proposal, might simply be the straw that broke the camel's back. The key sentence:

The demand came a day after ND issued a nonpaper saying that the party will support the new government's policies, only to reverse them when the conservatives come to power.

The implication is that the New Democracy party hopes to pull in the next tranche of aid, then default. CR suggests they just say so, and get the default over with. I have to agree - we all know the latest haircut of 50% - not including official debtholders, of course - will prove to be insufficient, as additional austerity measures erodes the government's fiscal position.

And that story is growing throughout the Eurozone. Consider this report:

France announced 65 billion euros of tax hikes and budget cuts over five years on Monday, as President Nicolas Sarkozy seeks to protect the country's creditworthiness in financial markets without killing his chances of re-election in six months time...

...But economists said the government's growth outlook was still too optimistic, even after cutting the forecast for 2012 to 1 percent from 1.75, meaning the latest measures might not be enough for France to meet its deficit reduction goals.

As the periphery moves to austerity, it weakens the core, and the core turns to additional austerity. Which then weakens the periphery. Slow, but vicious, cycle.

Good luck with that - it has obviously worked so well in the rest of the Eurozone. Meanwhile, the 10 year Italian bond rate rose to 6.77 percent, a whopping 497bp premium to Germany. Many believe that 6 percent is the point of no return, and we are well past that mark. Italian bonds might get some relief from Berlusconi's departure, but within three to six months they too will be falling short of their fiscal benchmarks, and bond markets will be forced to react.

Meanwhile, the ECB is effectively on the sidelines. Ed Harrison at Credit Writedowns has been providing some excellent commentary, and believes it is only a matter of time before the ECB brings out the big guns and gives Europe what it needs, a lender of last resort. Which makes perfects sense because that is the only way in which the Eurozone does not fall into depression. That said, ECB members are determined to prove him wrong. From Bloomberg:

European Central Bank council member Jens Weidmann said the ECB cannot bail out governments by printing money.

"One of the severest forms of monetary policy being roped in for fiscal purposes is monetary financing, in colloquial terms also known as the financing of public debt via the money printing press," Weidmann, who heads Germany's Bundesbank, said in a speech in Berlin today. The prohibition of monetary financing in the euro area "is one of the most important achievements in central banking" and "specifically for Germany, it is also a key lesson from the experience of hyperinflation after World War I," he said.

In the United States, we live under the legacy of the 1970's. For Europeans, it is the 1920's. And with that fateful decade in mind, the resistance of certain Eurozone stakeholders - yes, Germany - remains steadfastly in the path of very aggressive monetary policy.

Bottom Line: Yes, Europe is bad. And getting worse. By the time European policymakers reach an agreement, the goalposts have moved. They are literally looking into the abyss, caught like deer in the headlights. And like the US in 2007, they cannot avoid the abyss. And yet, US equities markets hang on, edging upward in the apparent belief - or delusion - that a European financial crisis will not filter back into the US. I hope that is correct, but suspect it is not. And if it not correct, I don't anticipate equities will react until it is obvious corporate profits will suffer.

...nothing upsets people like the perception that the rules don't apply equally to everybody..., what many people felt after the 2008 bailouts of the financial system. The system was certainly at risk, and some government intervention was just as certainly necessary. Yet it ... didn't escape most Americans that TARP was the largest welfare program for corporations and their investors ever created in human history. ... TARP wasn't just the triumph of Wall Street over Main Street; it was the triumph of K Street over the rest of America.

The way the bailout was conducted damaged Americans' faith in their financial system, in their government, and in the market economy. ... Their altered feelings weren't the consequence of any ideological bias against government involvement; on the contrary, a majority of respondents believed that the government should regulate financial markets. They objected, rather, to the specifics of what the government was doing. One reason they objected was their perception that lobbying interests had influenced the intervention: 50 percent of respondents, for instance, thought that Paulson had acted in the interest of Goldman Sachs, not the United States.

But a stronger reason, presumably, was that the bailout made the system suddenly look fundamentally unfair. Why should outsourced workers, whose only fault was to have entered the wrong sector, bear the burden of market discipline, while rich bankers were offered a government safety net? ...

Senators, Republicans and two Democrats in particular, have not received anywhere near enough criticism for this:

Last week's Senate decision to kill a modest $60bn bill to upgrade America's infrastructure before it came to debate may have exceeded even that august chamber's recent record. The package, which included $10bn in seed money for a public infrastructure bank, was blocked by every Republican and two Democrats. They objected because it would have been funded by a 0.7 per cent surtax on earnings over $1m.

And that was that. At a time when US businesses prefer to hoard rather than invest their cash, and when long-term interest rates are so low the money is virtually free, the political system is unable to accomplish what ought to be a no-brainer. Until now, America has never faced an ideological divide on infrastructure: both parties accepted the need to upgrade roads, dams, bridges, energy and water systems.

Forget Abraham Lincoln and Dwight Eisenhower, the presidents most often cited as having unleashed growth-boosting infrastructure – transcontinental railroads and federal highways respectively. Forget even Bill Clinton's cheerleading for the "information superhighway", which helped pave the way for the spread of the internet...

We need go back only to 2005 when a Republican-controlled Capitol Hill pushed through the infamous $280bn Highways Act, which was the largest transport bill in US history. ...

The US spends just 2 per cent of its gross domestic product on infrastructure. The European Union spends twice that, and China more than four times. It is showing. ...

It's not just the crumbling infrastructure, though that that alone is enough to justify the spending -- especially at a time when interest and other costs are so low -- it's the way in which Congress has all but turned its back on the unemployed. We have an opportunity to provide employment and at the same time invest in projects that have clear net benefits. Yet politics stands in the way and millions of unemployed face a less hopeful future because of it. People who have done nothing wrong except get caught up in a recession -- people who, when they have jobs, show up every day and work hard in support of their families -- are stamped with permanent scars from long-term unemployment. They wonder when, if ever, they will find a job again (and if they do find one what type of job it will be). Yet we do nothing to help them even though meeting our great infrastructure needs could help with the unemployment crisis. Grrr.